CIM Stock: Is This 10.5% Yield Too Good to Be True?

Should Income Investors Consider This Double-Digit Yield?

In today’s market, many ultra-high yielders are simply the by-products of their terrible share price performance. And in most of those cases, you’d be better off standing on the sidelines, because at the end of the day, who wants to own a stock that’s falling off a cliff?

The good news is, not all high-yield stocks belong to that category. Chimera Investment Corporation (NYSE:CIM), for instance, offers a generous dividend yield of 10.5%, and its share price didn’t really drop to the floor. In fact, over the last 12 months, shares of Chimera Investment Corporation have climbed 7.7%, and in the last five years, CIM stock shot up 46.6%.

Chimera is a real estate investment trust (REIT) that specializes in mortgages. The company invests in both mortgage loans and mortgage-related securities. Profit comes from the interest earned on its mortgage investments, less the cost of its borrowings. And because the company chooses to be taxed as a REIT, it must distribute at least 90% of its taxable income to shareholders every year through dividends.

High-yield stocks are not known for their dividend safety. But at this mortgage REIT, the payout is actually safe.

Chimera reported earnings on November 2, 2017. In the third quarter of this year, the company generated $129.8 million in net income or earnings of $0.69 per share. Given its quarterly dividend rate of $0.50 per share, Chimera had a payout ratio of 72.5%. (Source: “Chimera Investment Corporation Releases 3rd Quarter 2017 Earnings,” Chimera Investment Corporation, November 2, 2017.)

In the first nine months of 2017, the company generated $2.09 in earnings per share while declaring total dividends of $1.50 per share. That translated to a payout ratio of 71.8%.

Here at Income Investors, we like to see companies that pay out less than 75% of their profits. Chimera’s financial results suggest that its dividends are quite safe.

Of course, if this double-digit yielder is perfect, income investors would rush towards it, bidding up its share price and lowering its yield. But we don’t really see that happening. As a matter of fact, Chimera stock’s dividend yield has remained above 10% for quite some time.

So what’s the concern? Well, like most mortgage REITs, Chimera makes money by borrowing short and lending long, earning what’s called the interest rate spread. For the most part of the last decade, the federal funds rate were kept at extremely low levels, which allowed Chimera to earn a huge spread between its borrowing rates and lending rates.

Most recently, however, the U.S. Federal Reserve has been raising its benchmark interest rates. This could lead to narrower spreads for Chimera, causing its portfolio value to decline. The company estimated that a 50-basis-point increase in short-term interest rates would cause a 3.1% decline in the market value of its agency securities.

Fortunately, the company is not standing still. It uses derivatives—including interest rate swaps, options, and futures—to hedge interest rate risk. With these hedging strategies, Chimera’s portfolio value would only decline by 0.8% when short term rates rise by 50 basis points. (Source: “Investor Presentation,” Chimera Investment Corporation, last accessed December 21, 2017.)

So there you have it: the company is not perfect. But for investors who want to earn a yield north of 10% in today’s market, Chimera Investment Corporation is one of the few names worth considering.

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